Friday, November 14, 2008

In what continues to be one of the biggest wastes of breath and digital ink in recent memory, the debate over "deflation" continued this week with Eric Janszen of iTulip contributing one of the more stinging attacks against the "deflationistas" in some time.

Maybe someone should lock Eric and Mike Shedlock in a room together until they finally come around to realize that the only thing they disagree on are definitions and timing.

After listening to this interview from just a few months ago, I'm not even sure that Mish deserves the label "deflationista", loosely defined as those who think we are about to sink into a 1930s-style deflationary depression from which, if things go according to plan, we will all emerge sometime around 2020.

[And, while I'm at it, stop stealing my charts - I've been doing these for over a year now.]

The deflationary abyss is apparently preordained, even though there is no gold standard this time around and, as a consequence, virtually no limit to what central banks and governments can do in an attempt to "paper over" the basic problems we now face in the global economy.

For that group, which includes most of the folks at Elliot Wave, I have these thoughts:

The fundamental problem with "deflationistas" is that they transfer their own apocalyptic view of the world onto the two groups who will ultimately determine whether we sink into a deflationary abyss:

a. Central banks and governments who, with a pure fiat money system, have the ability to create money and credit out of thin air with virtually no limit;

b. Ordinary consumers in the West who are innately optimistic about the world and more than willing to borrow and spend when presented with favorable terms as well as new consumers in emerging economies around the world who aspire to be as profligate as those of us in the West

Back to Mr. Janszen... He has penned another memorable piece this week:

The deflationistas apparently think what comes after post-bubble deflation is more deflation, as occurred in the early 1930s in the US but nowhere else ever since. It has not occurred to the deflationists why no similar period of deflation has ever occurred since the 1930s, or when they do confront the question they explain that the debt is really, really, really big debt this time, bigger than the Fed. Or that differences between the kind of money that the Fed prints versus the kind of money that the endogenous credit markets create when money is loaned into being by businesses and consumers means the Fed cannot impact the latter.

As we explain that in The truth about deflation, the reason no deflation spiral has occurred in any nation since the one instance in the US in the 1930s is because since then no nation has chosen to remain on the gold standard through a debt deflation. Needless to say, the US is not on a gold standard today....In this crazy environment what is likely to happen, as has happened in the past, is that the bond market will figure out all at once that pricing signals it mistook for a long term deflationary headwind were actually the deflationary down draft of a collapsing asset bubble followed by a powerful inflationary tailwind that started off as Fed induced money growth years before. Anyone caught on the wrong side of the market when that epiphany finally occurs will suffer the consequences. The deflationistas can take this as their final warning from the inventors of the original deflation/inflation cycle theory.

Eric then goes on to describe his own Ka-Poom Theory of rapid inflation sometime in the period ahead, beginning shortly after everyone who is currently talking about "deflation" stops doing so as they notice all kinds of prices rising again.

The piece is well worth reading in its entirety and is highly recommended.

I'm in the process of writing something up for my weekly investment newsletter and will probably provide excerpts of the wasted digital ink here sometime next week.

16
comments:

Anonymous
said...

this is not too different from the loopy debate carried out over the last year about whether or not we are in a recession.. it's an unimportant footnote to the more important event taking place, namely, the collapse of a giant credit bubble and the government's response to it....

The root question I see is whether we're in for extended deflation as 'deflationistas' seem to think or whether something like (high or even hyper) inflation will follow a relatively brief 'disinflationary' period as others think.

That's an extremely important question in my view since you will act differently depending on which one you believe.

There are, of course, other possibilities but to say that this question isn't worth debating or is a 'loopy' debate makes no sense to me.

If we're in for extended deflation, then the Fed can 'print' money without fear of causing too much inflation.

If, however, the lack of a gold standard means that every dollar 'printed' will contribute to inflation, then the Fed's recent actions and likely future course of printing gobs of money is a very bad idea.

I read iTulip and a few other commentators as taking the latter point of view and I think it's a valid concern.

It seems that, at the moment, most commentators don't see any risk of high or hyper inflation.

Those who disagree with the iTulip view seem to be arguing that hyperinflation can't happen in the US - EVER - regardless of how much paper money is created from nothing.

That view seems illogical to me and I see a BIG difference between iTulip's views and those of many others.

Whether Mish is in this camp or that camp doesn't matter to me since the lines have been drawn out there and the personalities are irrelevant.

Either hyperinflation is likely/possible in the US or it isn't. It's a worthy debate because policy will be biased one way or the other.

Right now, Bernanke & Co. are biased against the possibilities of high/hyper inflation. They could be wrong and that's what I believe Janszen at iTulip is saying in a nutshell.

Part of the problem with this debate is that economists and central bankers have a completely different notion of what "inflation" and "deflation" are, so, trying to figure out what they might do as a result of this discussion is kind of a dead end.

For example, if you include home prices in the CPI, you could argue that we had no real "deflation" scare back in 2003 and that we had "deflation" last summer when oil was at almost $150 a barrel.

The core point for me may be just too simple. I see the lack of a 'gold' standard as a major problem for the US and the world in the long run.

The Feds play with the figures by defining 'inflation' as required to get the results they want.

But, if the lack of any tangible backing for the US dollar is a BIG problem (as Ron Paul, I and many others believe), the Feds won't be able to stop interest rates from rising as the dollar becomes worth less and less from over 'printing.'

At some point, theoretical definitions become useless since reality will have landed and the ivory tower debates over CPI, hedonics, etc. won't make a dime's difference.

The debate over the lack of a gold standard is important to those of us who feel it is the key to fixing what's wrong with our financial system right now.

Debt got us into this problem, individually and as a nation. More debt is not the answer.

Draconian measures will be required at this point. The longer we wait, the worse it gets.

We could have elected Ron Paul this time if more people had understood what he was talking about. This debate may be the only thing that will save our country from financial melt down.

WELL, there is the example of Japan, which kind of had a deflation, and weren't noticeably on any kind of gold standard....they've been on the ZIRP forever, the Nikkei is back to where it was in the 80's and if they aren't in deflation, they sure aren't having any inflation problems.

Plus the arguments that Mish and others make is twofold: That consumers experience a permanent shift in behavior wrt the use of debt, and that due to the "miracle" of leverage, money is being deconstructed faster than the Fed can shovel it out.

It seems a worthwhile argument to me, as Nostra pointed out, it is critical to any investment strategy.

My personal guess which is worth every penny you paid for it, is that we get the worst of both worlds: deflation in wages, bankruptcies up the ying yang, and inflation in the things you can't do without, like food and energy.

From Puru Saxena:Central banks and governments are printing TRILLIONS of paper currencies around the world, the US has now become a socialist society and all this money-creation should result in a huge inflationary tsunami in the future. In my opinion, those who are forecasting deflation, don't understand our monetary system. What we have seen in the recent past is not deflation but a contraction in asset prices due to liquidation.

When I read Robert Prechter's book.."Conquer the Crash” (several years ago),I thought his predictions were unlikely.Many of Mr. Prechter’s predictions have come to pass.1)Terrorism on US soil.2)The failure of Fannie Mae and Freddie Mac3)Bailouts for the US auto industry.It’s all unfolded in S-L-O-W motion.Prechter predicts deflation. How? The boom is based on Credit, not printed fiat money. When easy credit is withdrawn, asset prices decline.A self reinforcing feedback loop s-l-o-w-l-y accelerates the deflation process.1) Asset prices decline. 2) Assets are sold to service debts. 1) Asset prices decline.Comparing “a contraction in asset prices” to deflation, I sayIt’s a distinction without a difference.

The flaw I see with Prector's theory/cycle is that there's no mention of how government obligations require them to "print" trillions to replace lost credit. Eventually the lost credit is replaced but the money creation has to continue to fullfill the obligations. In a depression those obligations only get bigger (a multitude of bailouts, giveaways, expansions of various forms of welfare, etc). I have a hard time seeing how it doesn't get out of control at some point.

I'd apologize, except for the following. It has come to my attention that commenters on your posts that have used these charts have informed you on at least two occasions that you are duplicating what I've already done. This has happened before for charts that I've created and, normally, the author graciously acknowledges that, while their idea may be quite original, it is also quite late, relatively speaking (Justin Fox at Time Magazine did this earlier in the year). I think this happened to me once, a long time ago, and I wrote some kind of an acknowledgement like, "It has come to my attention that so-and-so has been generating these charts for some time now..."

You wrote:"Do you seriously think you were first with this idea?"

I don't know. Ask Kevin Phillips who saw fit to include one of these charts in his 2007 book Bad Money. They do pretty thorough research and probably would have included someone else's chart if it had been available.